Explain important functions of commercial banks.

Answer:

1.      Primary Function:

       i.            Accepting Deposits:

It is the most important function of commercial banks. They accept deposits in several forms according to requirements of different sections of the society.

The main kinds of deposits are:

a)      Current Account Deposits or Demand Deposits:

These deposits refer to those deposits, which are repayable by the banks on demand:

Ø  Businesspersons with the intention of making transactions with such deposits generally maintain such deposits.

Ø  A chequeen without any restriction can draw upon them.

Ø  Banks do not pay any interest on these accounts. Rather, banks impose service charges for running these accounts.

b)      Fixed Deposits or Time Deposits:

Fixed deposits refer to those deposits, in which the amount is deposited with the bank for a fixed period of time.

Ø  Such deposits do not enjoy chequeen-able facility.

Ø  These deposits carry a high rate of interest.

c)      Saving Deposits:

These deposits combine features of both current account deposits and fixed deposits:

Ø  The depositors are given chequeen facility to withdraw money from their account. But, some restrictions are imposed on number and amount of withdrawals, in order to discourage frequent use of saving deposits.

Ø  They carry a rate of interest which is less than interest rate on fixed deposits. It must be noted that Current Account deposits and saving deposits are cheatable deposits, whereas, fixed deposit is a non-cheatable deposit.

     ii.            Advancing of Loans:

The deposits received by banks are not allowed to remain idle. So, after keeping certain cash reserves, the balance is given to needy borrowers and interest is charged from them, which is the main source of income for these banks.

Different types of loans and advances made by Commercial banks are:

a)       Cash Credit:

Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is credited in his account. The borrower may withdraw any amount within his credit limit and interest is charged on the amount actually withdrawn.

b)      Demand Loans:

Demand loans refer to those loans which can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interest is payable on the entire sum.

c)       Short-term Loans:

They are given as personal loans against some collateral security. The money is credited to the account of borrower and the borrower can withdraw money from his account and interest is payable on the entire sum of loan granted. 

2.      Secondary Functions:

a)      Overdraft Facility:

It refers to a facility in which a customer is allowed to overdraw his current account up to an agreed limit. This facility is generally given to respectable and reliable customers for a short period. Customers have to pay interest to the bank on the amount overdrawn by them.

b)      Discounting Bills of Exchange:

It refers to a facility in which holder of a bill of exchange can get the bill discounted with bank before the maturity. After deducting the commission, bank pays the balance to the holder. On maturity, bank gets its payment from the party which had accepted the bill.

c)      Agency Functions:

Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients.

3.      Some of the agency functions are:

a.      Transfer of Funds:

Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like demand drafts, mail transfers, etc.

b.      Collection and Payment of Various Items:

Commercial banks collect cheques, bills,’ interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.

c.       Purchase and Sale of Foreign Exchange:

Some commercial banks are authorized by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.

d.      Purchase and Sale of Securities:

Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.

e.       Income Tax Consultancy:

They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.

f.        Trustee and Executor:

Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.

g.      Letters of Reference:

They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.

4.      General Utility Functions:

Commercial banks render some general utility services like:

a.               Locker Facility:

Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody.

b.               Traveler’s Cheques:

Commercial banks issue traveler’s cheques to their customers to avoid risk of taking cash during their journey.

c.                Letter of Credit:

They also issue letters of credit to their customers to certify their creditworthiness.

d.               Underwriting Securities:

Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks.